Expect RBI to front-load primary liquidity injection to pre-empt tightness

IN line with the market expectations, the RBI left policy rates unchanged(rep oat 6.5%, C RR 4%) and reiterated its commitment to move towards neutral liquidity conditions. The RBI highlighted the need for transmission of past policy rate cuts (150bps so far) and consequently announced a review of the marginal cost lending rate (MCLR) framework of banks.

While the central bank retained its baseline estimates for growth (FY17 at 7.6%) and inflation

(Jan-Mar’17 at 5%), a notable shift in June policy was RBI’s acknowledgement of an “upside bias” to its inflation projection. The upside risks broadly emanate from rising commodity prices, implementation of the 7th Pay Commission and a recent pick-up in household inflation expectations, though a strong monsoon (if realised) and a proactive food management policy could offset the risks somewhat. Notwithstanding increased uncertainty around its inflation projection, the RBI reiterated its “accommodative” monetary policy stance.

Factoring in Indian Met’s projection of excess rainfall this fiscal (delayed onset is a concern though), we continue to believe that the downside risks on inflation may outweigh the upside risks, opening up the scope for a residual 25 bps rate cut. However, we expect the RBI to remain in a wait-and watch mode in H1 on account of adverse base effects and monsoon uncertainty.

The central bank has been walking the talk on liquidity with the injection of Rs70,000 crore of primary liquidity through open market operations in the first two months of this fiscal. Though the pressure on liquidity could wane in the near term (June-August period typically sees a reduction in currency in circulation by ~R23,000 crore), we expect the RBI to continue to front-load its primary liquidity injection to pre-empt any tightness ahead of the maturing FCNR deposits ($26bn outflow in the Oct-Nov period ). We now see an upside to our estimate of FY 17 OM Oo fR 1.2 lakhcrore.